Global Weekly Commentary: Our latest credit views
Upgrading EM debt
We have upgraded emerging market (EM) debt on a tactical basis as positive vaccine developments bolster the case for an accelerated global restart in 2021.
Global stocks hit record highs as the transition of power officially started in the U.S. The rally fizzled on the virus resurgence and disappointing jobs data.
This week’s U.S. nonfarm payrolls data will be in focus after recent data pointing to softening activity. Markets are also waiting for a potential Brexit trade deal.
We have closed our tactical underweight in EM debt as easy monetary policy is expected to stay, against the background of an improved 2021 outlook. Positive news on Covid vaccine development has boosted the case for an accelerated global restart in 2021. This latest view change reflects our barbell approach between quality and cyclicality – with a tilt to cyclicality in our credit exposures.
Chart of the week
Total return of selected bond indexes, year-to-date 2020
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv, November 2020. Notes: The indexes used are the Bloomberg Barclays Global High Yield Index, JPMorgan EMBI Global Diversified Index and JPMorgan GBI-EM Composite Index. Performance is indexed to 100 on Jan. 1, 2020.
EM assets have underperformed their developed market (DM) peers for most of 2020, and have been playing catchup in recent weeks. A string of positive news reports on Covid vaccines boosted confidence in an accelerated restart during the course of 2021, setting up a positive overall backdrop for risk assets. Encouraging early results on the effectiveness of a Covid-19 vaccine that may offer lower costs and easier distribution bode particularly well for the EM world, in our view. Most EM assets have now delivered positive year-to-date returns after the recent rally. EM local-currency debt has lagged the market recovery in U.S. dollar terms, dragged down by heavy currency depreciation in many emerging markets. See the chart above. Yet we see potential for EM local-currency debt to catch up as EM currencies stabilize thanks to a stable or moderately weaker U.S. dollar. We also expect EM hard-currency debt to keep pace with high yield credit in developed markets, as higher yielding debt looks attractive to investors in search of income.
The U.S. dollar is a key driver behind EM local-currency debt. We see risk appetite and interest rate differentials in turn driving the dollar’s moves. More positive risk appetite as a result of the improved economic outlook should limit the demand for perceived safe-haven assets such as the dollar, in our view. At the same time, we see declining real rates as inflation firms and the Federal Reserve caps any gains in nominal bond yields. The likely result is a moderately weaker dollar. This should support EM currencies and local-currency debt. We also expect more predictable foreign affairs and trade policies under the Biden administration to provide an improved backdrop for the EM world. Our BlackRock geopolitical risk dashboard – tracking market attention to the top 10 geopolitical risks – shows attention to global trade tensions has dropped sharply from recent peaks after staying at elevated levels for much of the past three years.
China is an important part of EM growth dynamics. The world’s second-largest economy is leading the global restart in activity, with its growth already at, or very close to, its pre-Covid trend. This bodes well for the rest of the EM world. Yet EM economies are also susceptible to the policy direction of China. Any aggressive tightening of monetary policy in China to prevent the economy from overheating – not our base case – could be negative for the rest of the EM complex, in our view. Another risk for some emerging markets: structural growth challenges and sharply rising debt levels in the wake of the Covid shock. Yet we do not see this as a near-term market risk due to ample global liquidity. Tactically we are overweight Asia fixed income as this region leads the global economic recovery. We view valuations in this market as attractive – and believe investors are well compensated for the risks. We are also overweight high yield – on both tactical and strategic horizons – as it provides attractive income in a yield-starved world.
The bottom line: We expect global growth to rebound strongly in 2021 with the rollout of Covid vaccines. This is why we prefer to tilt more toward cyclicality in our credit views as we take a barbell approach to allocate risk exposure to both quality and cyclical assets. We have upgraded both local-currency and hard-currency EM debt to neutral, after having upgraded EM equities to overweight. Meanwhile we have downgraded global investment grade credit as its valuations have increased and we prefer more cyclical exposures such as high yield.
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